We will look into calculation of depreciation with each method one by one and then answer the questions.
Method 1 : Straight line method
Cost of aircraft = $64,400,000 Residual Value of aircraft = $64,00,000 Useful Life = 5 years
Depreciable Value = Cost of aircraft - Residual Value = $64.400,000 - $64,00,000 = $58,000,000
Depreciation for first year = Depreciable value / Useful life = $58,000,000 / 5 = $11,600,000
Method 2 : Units of production method
Cost of aircraft = $64,400,000 Residual Value of aircraft = $64,00,000 Miles expected over useful life = 7,000,000 miles
Depreciable Value = Cost of aircraft - Residual Value = $64.400,000 - $64,00,000 = $58,000,000
Depreciation for first year = (Depreciable value / Expected miles over useful life) x Expected miles in first year = ($58,000,000 / 7,000,000) x 775,000 = $6,421,429
Method 3 : Double declining method
Cost of aircraft = $64,400,000 Residual Value of aircraft = $64,00,000 Miles expected over useful life = 7,000,000 miles
Depreciable Value = Cost of aircraft - Residual Value = $64.400,000 - $64,00,000 = $58,000,000
Straight line depreciation % = (Straight line depreciation / Depreciable value) x 100 = (11,600,000 / 58,000,000) x 100 = 20%
Depreciation for first year = 2 x Straight line decpreciation % x Depreciable Value = 2 X 20% x 58,000,000 = $23,200,000
Summary
Method | Depreciation in first year |
Straight line method | $11,600,000 |
Units of production method | $6,421,429 |
Double declining method | $23,200,000 |
Question 1) As you can see Double depreciation method makes the highest depreciation. Depreciation is an expense, and as expense increases profit decreases. Tax is calculated on profit. So lower profits make higher tax savings. Since we should increase expense to lower profit, choosing the method with highest depreciation will save more tax in first year. Thus Double declining method offers highest tax saving.
Question 2)
Tax savings = Depreciation in first year x tax rate
A.Tax savings straight line method = $11,600,000 x 32% = $3,712,000
B.Tax savings Double declining method = $23,200,000 x 32% = $7,424,000
C.Extra tax saved = A - B = $3,712,000
On January 1, 2017, AmerEx Transportation Company purchased a used aircraft at a cost of $64,400,000....
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